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Cash Hoards Lend Thrust to U.S. Capital Investment

Capital spending begins to accelerate, as U.S. businesses spend down cash reserves and take advantage of easing credit.

Capital spending is poised to accelerate, giving the U.S. economic expansion a fresh boost after investment lagged way behind the half-century average.

Goldman Sachs Group Inc. economists said their “capex tracker” of 15 indicators, such as loan demand and capital-goods orders, shows a speed-up in nonresidential spending may already have begun. They see such investment climbing in 2014 by 7.5 percent, more than twice the forecast for 2013. Economist Joe Carson of AllianceBernstein LP predicts a broad-based surge with staying power.

Behind the optimism is a confluence of positives: Corporate America is lean and flush with cash, credit is easing, and aging durable goods from machinery to cars need to be replaced. A pickup in business spending would be welcome for an economy held back by cuts in government outlays, the January tax increase, and the partial federal shutdown.

“We’re on the cusp of some significant changes that have the potential to give a powerful lift to investment,” said Carson, director of global economic research at New York-based AllianceBernstein, which has $445 billion under management. Compared with the performance since the recession ended in June 2009, there’s a “much broader advance coming,” he said.

Production and investment are starting to climb, based on announcements by companies from automaker General Motors Co. to aircraft manufacturer Boeing Co. That in turn benefits suppliers including United Technologies Corp., the maker of Pratt & Whitney engines, and steelmaker Nucor Corp.

Stocks advanced as investors awaited data this week on jobs and economic growth. The Standard & Poor’s 500 Index rose 0.4 percent to 1,770.49 as of 4 p.m. in New York. The Dow Jones Industrial Average rose to a record close of 15,746.88.

Signs of the U.S. investment resurgence, driven by the automobile and housing rebounds and the move toward American energy independence, contrast with the rest of the world. Western Europe is sluggish, China is cooling, and emerging markets in Latin America and the Asia-Pacific region are showing “capex fatigue,” according to a July report from Standard & Poor’s Ratings Services.

S&P projects that North America, principally the U.S., will account for a decade-high 36 percent of global nonfinancial capital spending this year, up from a low of 24 percent in 2009.

Weak Beginning

Companies have catching up to do after a virtual “drought” in investment in this expansion, David Mericle of Goldman Sachs said in an Oct. 14 report from a team led by Chief Economist Jan Hatzius. The value of all equipment, structures, and intellectual property per worker rose 0.1 percent a year on average from 2010 through 2012, down from about 1 percent in comparable periods following prior recessions since 1960.

“This low starting point is a positive for the investment growth outlook,” Mericle said in the report. After a weak first half in 2013, business investment over the next year will climb by 10 percent on equipment, 8 percent on structures, and 5.5 percent on intellectual property products, Mericle forecasts.

U.S. private investment, including housing and inventories, will rise at more than twice the pace of economic growth in 2014 and 2015, according to the median forecast in a Bloomberg survey in early October.

Among the earliest to gear up are companies such as Hartford, Connecticut-based United Technologies, which is increasing spending for jet-engine production as it prepares for a ramp-up in aircraft manufacturing at customers such as Boeing, and demand for spare parts.

“There’s a lot of capex coming in the fourth quarter of this year; you’ll see even more next year,” Chief Financial Officer Greg Hayes said of his company’s plans during an Oct. 22 call with analysts.

United Technologies also is benefiting from a recovery in commercial and multifamily residential construction. In its Otis elevators unit, “bookings look very strong,” Hayes said.

Auto Opportunities

The outlook for business spending is getting a boost from carmakers, which are projected by Autodata Corp. to record this year the most U.S. deliveries since 2007. Suppliers, already operating at about 80 percent of capacity, will have to start expanding to keep up with sales, said Dave Andrea, senior vice president of industry analysis and economics at the Original Equipment Suppliers Association, a trade group based in Troy, Michigan.

GM plans to invest about $16 billion on U.S. factories and facilities through 2016, the Detroit-based automaker said in May. Ford Motor Co. will boost annual investment to about $7.5 billion by mid-decade, from a prior forecast of $6 billion, Chief Financial Officer Robert Shanks told investors at a conference in August. The Dearborn, Michigan-based automaker sees “improved near-term cash flows” and additional investment opportunities beyond 2015, he said.

“We’re going to be taking our capital spending to higher levels because we believe that we’ve got a lot of momentum and some really, really great growth opportunities,” Shanks said in the presentation.

Energy-related exploration and infrastructure investment will feed off the oil-production boom in North Dakota and Texas and the rise of hydraulic fracturing for natural gas. Diamondback Energy Inc. plans to drill 65 to 75 horizontal wells in 2014, at an average cost of $6.9 million to $7.4 million each, as it doubles production. Its capital spending will jump to $425 million to $475 million, up about 48 percent from this year’s projected level, the Midland, Texas-based company said Oct. 23.

Energy and automotive demand is rippling through to industries including steelmaking, driving earnings at companies such as Nucor. U.S. steel plants were running at an average 78 percent of capacity in the third quarter, up from 75 percent a year earlier, American Iron and Steel Institute data showed. Increased capacity utilization can be a prelude to fresh investment.

Other industries also are participating in the improvement. Wal-Mart Stores Inc., the world’s largest retailer, said Oct. 15 that it will boost capital spending in the U.S. for fiscal year 2014, while trimming it for overseas markets. The company will accelerate U.S. small-format store openings and e-commerce fulfillment centers, it said in an Oct. 15 release.

Driving the expansion are strengthening corporate finances, resilient U.S. demand, stabilizing overseas markets, and easing credit. All are helping to “clear the decks” for a resurgence in capital spending, said John Canally, an investment strategist at Boston-based LPL Financial Corp.

Nonfinancial companies had $1.8 trillion in liquid assets including cash at the end of the second quarter, close to a record high, Federal Reserve figures show.

Corporate finance chiefs forecast capital spending will rise 4.8 percent over the next year, according to a September survey of 530 U.S. firms conducted by Duke University’s Fuqua School of Business and CFO Magazine. That’s up from the 3.7 percent growth rate they expected a year earlier.

Investment Hurdles

The projected ramp-up in investment won’t happen overnight, nor is it without hurdles, economists including Carson and Canally caution. They point to regulatory and tax changes, the new health-care law, and fiscal constraints such as the federal budget cuts known as sequestration. Borrowing conditions will be less easy once the Fed begins to withdraw stimulus.

The investment rebound won’t necessarily bring more jobs, as companies seeking to limit costs may choose to spend on cutting-edge equipment and software instead of adding workers.

Some companies are hesitant to commit to big investments after they came close to “losing it all” in the recession, said Bill Diehl, chief executive officer of BBK Ltd., which helps clients such as GM and Oshkosh Corp. to improve efficiency at suppliers.

Even so, “you’re starting to see the ordering,” said Diehl, whose Southfield, Michigan-based advisory firm consults with manufacturers of everything from die-cast parts and electronics to parts for heavy equipment and automobiles. “You’re not going to see the switch change and all of the sudden you go from nothing to a lot. You’re just going to see that gradually rise.”

Companies are raising spending to replace old equipment and meet current demand, while holding off on investment for future growth, Diehl said. That may still happen “as we get further away from ’09 and the stability of the economy gets better,” he said.

Even though the U.S. emerged from the recession more than four years ago, leading indicators such as purchasing-manager surveys are only now showing a turn in capital spending that’s more typical of the early stages of a rebound, indicating business investment is set to gather steam, said AllianceBernstein’s Carson.

Extending Expansion

The resulting boost to growth may help extend the economic cycle “well beyond” the average length of past ones, he said. American manufacturing is now more competitive than it has been in decades, backed by relentless cost control, constant innovation, and the adoption of new technologies, which may encourage companies to invest in expansion, he said.

LPL’s Canally said capital spending may become “the best-performing part of the economy,” given that it outpaced gains in consumer purchases and residential investment in the second half of every expansion since 1960. “We’re likely to see the same kind of pattern,” he said.

“The conditions are in place, it’s just a matter of getting that spark,” said Canally, who helps manage about $414 billion. “Then you’ll see a move from fear to greed.”

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